There are two common mistakes that startup founders make:
- Giving away too much equity at the start, or
- Assuming a 50:50 arrangement with a co-founder is fair.
In a startup’s initial stages, it’s easy to get caught up in the startup’s rapid growth and overlook issues such as protecting the startup from co-founders leaving or who aren’t interested in building the idea later on. As a co-founder, it is important to remember that building a startup is hard work, both physically and emotionally. With three in four startups failing, it should be no surprise that co-founders may leave unexpectedly. To protect a startup’s assets and equity, and ensure employees are rewarded for their sustained valuable contribution, a Share Vesting Agreement (or vesting schedule) should be one of the first documents you have drafted.
Investing in Vesting
The most common options vesting package spans for four years with a one-year cliff. Investors want to see this same vesting package as it ensures key employees do not walk away. A one year cliff means that the recipient of the vested shares will not receive any shares until the first anniversary of the start date, in which they will receive 25% of the shares. After this first anniversary date, vesting will occur monthly, with 1/48th of the options package granted each month. If you quit the job or are fired before the first anniversary, you receive zero shares.
Another common equity structure, primarily applied for advisors, is four-year vesting, optional cliff, with full acceleration on exit. The term “full acceleration on exit” means that if the startup is sold or is listed publicly through an Initial Public Offering (IPO), they receive 100% of the equity promised to them, even if the full vesting period is not complete. These “trigger events” can either be labelled as single triggers, such as ownership change, or a double trigger, where it is conditional upon the management’s termination within an interval specified.
Share Vesting Agreement Example
Here is an example of a share vesting agreement for a startup company with two co-founders and a VC. You receive 35% of shares yourself, 35% for your co-founder and 30% for the venture capitalist. The Share Vesting Agreement has set out a four-year term with a one-year cliff. Your co-founder stays for two years and then leaves, holding 17.5% of the shares. The remaining 17.5% will virtually disappear, and the existing shareholders will now have a larger percentage of the company.
Share Vesting Agreements must document the commercial terms of the vesting schedule. This may include the quantity of shares that vest in exchange for what period, assignment of intellectual property and the terms on which shares can be cancelled or transferred.
What about Unit Shares?
Australian startups have also looked into establishing a unit trust to hold shares. A unit trust allows the startup company to lend money to the trust to buy the shares. When shares are vested, co-founders are given units in the trust, which equate to shares in the startup company. This more complicated setup also avoids some issues around taxation and can remove personal liability.
A share vesting agreement is a key document for every startup. It is an important element of corporate structure and ensures stakeholders are treated fairly and equitably. Taking the initiative to request a vesting schedule be drafted will not only add to your credibility as a founder in front of potential investors, but it will also allow co-founders to avoid a harsher plan imposed by investors.
Questions about drafting a Share Vesting Agreement for your startup? Get in touch with our startup lawyers.